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2.
Economy.dot
INDIA
Economy
MARCH 19, 2010
UPDATE
BSE-30: 17,578
RBI’s surprise dose may be a preparatory one. We see RBI’s 25 bps policy rate hike
as a bid to catch up and address the problem of large negative short-term real interest
rates. The timing was a major surprise to the markets as it came even before the March-
end. We see this as an indication of further monetary policy action in April 2010 in line
with our earlier call of 50-100 bps policy rate hike on that day. We do not see any
adverse impact of the move on liquidity or interest rates.
RBI starts action to catch up with the curve
RBI today after close of markets hiked its policy rates by 25 bps with immediate effect.
Reverse repo rate, which is the operational policy rate today, has been hiked to 3.5% from QUICK NUMBERS
3.25%;
• RBI hikes policy
Repo rate, the policy rate that sets the upper end of the overnight interest rate corridor, has rates by 25 bps; first
been hiked to 5% from 4.75% time after July 2008
We see this RBI move as a bid to catch up with the curve (see Exhibit 1). In our Economy note of
• We expect further
March 15, 2010, “Would inflation and negative real interest rates damage the economy?” we had
pointed out that India runs the second highest CPI inflation in the world and also the most 50 bps policy rate
negative short term real interest rates (see Exhibit 2 and 3). We had pointed to risks of running hike on April 20
high negative real rates, viz., (1) possible asset price bubbles building again and (2) adverse impact
• India still runs the
on private savings. We had mentioned that RBI may need to raise policy rates by over 200 bps
largest negative
even with expected fall in inflation to sub-6% by end-FY11E in order to attain positive real rates.
We see RBI action as the first step in that direction. short term real rate
at -12.7%
We expect further monetary tightening in April 2010
We see RBI’s move as a preparatory step for more tightening on or before schedule policy date.
RBI may raise policy rates by another 50 bps on April 20. A CRR hike of 25-50 bps in April is
also possible if large liquidity returns. RBI may further raise policy rates by at least another 50
bps by end-July 2010, taking repo rate to 6% and reverse repo rate to 4.5%
In terms of timing, today’s move was a major surprise because RBI had clearly communicated to
the markets that it may act before scheduled policy date only if the underlying growth or inflation
conditions change due to unforeseen events. See also our Economy note of February 15, 2010,
where we said that RBI is unlikely to act to small deviations of say 1-ppt in its full year’s growth
and inflation projections. Our belief was also reinforced by likely larger than expected treasury
losses for banks in this quarter on account of MTM losses, which we thought would prompt RBI to
act only after March 31 closing. However, RBI has chosen to act when large liquidity has been
temporarily drained by March advance tax flows. We see this on account of:
(1) Increased confidence amongst policy-makers that high IIP growth would sustain, (2) Inflation
becoming a major political issue in India enabling RBI leeway to act, (3) further evidence that
manufacturing inflation is rising and it no longer remains food inflation (see Exhibit (4) large
repressed inflation coming to fore through petro price hike and likely increase in coal and steel
prices
RBI in its communication has cited the following reasons for its action: (1) Uptrend in IIP being
maintained, (2) acceleration in capital goods production, (3) headline WPI inflation exceeding
baseline projection of 8.5%, (4) CPI indices accentuating further, (5) increasing capacity utilization
and (6) rising energy prices. It has also added that “it will take further action as warranted.”
We retain our 10-year gilt yield call at 8% for end-FY10E and a high of 8.25% in 1QFY11E
before the bond rally takes over. We see INR/USD appreciating to 45.20 in near term before
weakening again.
For private Circulation Only. FOR IMPORTANT INFORMATION ABOUT KOTAK SECURITIES’ RATING SYSTEM AND OTHER DISCLOSURES,REFER TO THE END OF THIS MATERIAL.

6.
tl
CAUTIOUS
Energy
India MARCH 22, 2010
UPDATE
BSE-30: 17,578
Oil is not about oil alone. We continue to be puzzled by the continued strength in
crude oil prices despite its weak short-term fundamentals. Meanwhile, natural gas
prices continue to correct sharply, probably cramped by concerns of surplus in the peak
storage season given the rising production of non-conventional gas in the US. Optimists
looking at long-dated prices to support their positive thesis may have to contend with
this new and unexpected source of energy that could wreck crude oil’s fundamentals.
Crude firms up while natural gas prices decline; it all boils down to speculation, it would appear
Crude prices have risen over the past few weeks (+8% since February 1, 2010) upon expectations QUICK NUMBERS
of (1) strong demand recovery in CY2010E, (2) long-term supply-demand imbalance due to
declining OPEC spare capacity and (3) a decline in US product inventories. However, natural gas • Oil-gas price parity
prices have corrected 24% over the same period, probably on account of winter heating demand ratio at 3.5X
tapering off and signs of a large surplus in autumn. We understand the different usages of oil and currently in the US
gas but the 3X pricing differential is a puzzle, especially as refining capacity and availability of auto
fuels is not an issue and short-term fundamentals of crude appear weak. • OPEC spare capacity
at around 6 mn b/d
Dollar movement, speculation can ward off weak fundamentals, only for a while
in CY2010-11E
Oil optimists point to the increase in long-dated crude prices to justify their bullish stance on crude
oil prices. However, the rapid changes in long-dated prices in sync with near-month prices suggest • Shale gas F&D cost
that long-dated prices do not accurately assess long-term crude oil prices. In fact, they move up or at US$1.7/mn BTU
down based on near-month prices. Also, the synchronized movement of crude futures with and production cost
movement in the US dollar (DXY Index) and stock markets suggests that there is a strong link (without
between the three markets and speculation in crude futures based on movements in the DXY and transportation,
stock markets. taxes) at US$0.9/mn
BTU
Short-term and long-term views on oil no longer about oil alone
In our view, the short-term and medium-term fundamentals of crude oil do not support the
current level of crude oil prices. There is ample OPEC spare capacity, global inventories are
comfortable and supply of alternative energy is rising sharply in CY2010E. However, speculation
and DXY may have an equally big bearing on short-term crude prices. In the long term, crude will
have to contend with alternative energy sources—the potential of which is difficult to even fathom
at this point. In our view, it is practically impossible to factor in so many complex developments on
both the demand and supply side to make any accurate assessments of long-term prices; we
doubt any modeling can accurately forecast technological advancements in both conventional and
non-conventional hydrocarbons and alternative fuels; a few of them would be destructive in
nature.
Shale gas is becoming increasingly conventional
Our preliminary study of shale gas suggests that this can be a destructive force for the
conventional energy world. The technology for extracting shale gas is fairly common now,
resources are abundant across the world and F&D (US$1.7/mn BTU average over the past two
years) and production costs (about U$0.9/mn BTU in CY2009) are in line with those of
conventional gas; in fact, as the area benefits from economies of scale with more proven reserves
and as conventional resources dwindle, the cost curve may shift in favor of shale gas.
For private Circulation Only. FOR IMPORTANT INFORMATION ABOUT KOTAK SECURITIES’ RATING SYSTEM AND OTHER DISCLOSURES, REFER TO THE END OF THIS MATERIAL.

7.
Energy India
Short-term and medium-term views: Oil and gas on different planes
Exhibit 1 tracks price movements of oil and gas in the US. Oil prices have increased over
the past few weeks while gas prices have come off over the same period. We do not
deny that the markets for oil and gas are different, notwithstanding some convergence in
the heating area. However, the price difference is stark and has increased over the past
5-6 years to unprecedented levels in the US, one of the few markets with unfettered oil
and gas pricing. The crude oil-natural gas price ratio now stands at 3.46X compared to
1.21X in CY2004 (average prices for the year). This would suggest that crude’s
fundamentals are much tighter versus gas; however, that does not appear to be the case
in light of the following factors.
Gap between crude oil prices and equivalent natural gas prices has increased sharply of late
WTI crude price and Henry Hub gas price, 2004-10YTD
(US$/bbl) (US$/mn BTU)
160 18
WTI crude oil price [LHS] Crude price equivalent of Henry Hub gas [LHS] Henry Hub gas price [RHS]
140 16
14
120
12
100
10
80
8
60
6
40
4
20 2
0 0
Jan-04
Apr-04
Jul-04
Oct-04
Jan-05
Apr-05
Jul-05
Oct-05
Jan-06
Apr-06
Jul-06
Oct-06
Jan-07
Apr-07
Jul-07
Oct-07
Jan-08
Apr-08
Jul-08
Oct-08
Jan-09
Apr-09
Jul-09
Oct-09
Jan-10
Source: Bloomberg, Kotak Institutional Equities
Ample OPEC spare capacity over the next two years. We estimate OPEC’s spare
capacity at around 6 mn b/d in CY2010-11E (see Exhibit 2), in line with the current
spare OPEC capacity of 6.25 mn b/d (see Exhibit 3). The supply-demand balance looks
tighter in the outer years of our projections. However, this does not factor in likely
increased supply from (1) Iraq resulting from the recent award of technical contracts to
several global majors and NOCs, (2) contribution from Brazilian sub-salt plays, (3)
recent award of contracts in Venezuela’s heavy oil plays and (4) new discoveries off
the coast of West Africa (the belt stretching from Sierra Leone to Equatorial Guinea
with two billion-barrel discoveries already off the coast of Ghana).
KOTAK INSTITUTIONAL EQUITIES RESEARCH 7

9.
Energy India
Iraq’s production target of 12 mn b/d by CY2017 may appear ambitious compared to
its current 2.5 mn b/d production but even an additional 2-3 mn b/d of supply over
the next 3-4 years may dramatically alter the projections in the outer years of our
forecast. Iraq has awarded several technical contracts to global majors and NOCs (see
Exhibit 4) in order to exploit its 115 bn bbls of proved reserves, the third largest after
Saudi Arabia’s 264 bn bbls and Iran’s 138 bn bbls. We note that Saudi Arabia
currently produces about 8 mn b/d and has a sustainable production capacity of 12
mn b/d. Iran produces about 3.75 mn b/d of crude oil with a sustainable production
capacity of 4 mn b/d.
Iraq's crude oil production may reach 12 mn b/d in seven years
Summary of Iraq oil contracts awarded, CY2009
Reserves
Oil fields Consortium partners (bn bbls) Comments
Round 1 (June 2009)
South Rumaila BP, CNPC 7.3 Production target of 2.85 mn b/d from 1.06 mn b/d currently
West Qurna (Phase 1) ExxonMobil, Royal Dutch Shell 8.7 Production target of 2.3 mn b//d from 279,000 b/d currently
Zubair Eni, Sinopec, Occidental, Korean Gas 4.0 Plateau of 1.125 mn b/d from 200,000 b/d in seven years
Round 2 (December 2009)
Badra Gazprom, Turkiye Petrolleri, Korea Gas, Petronas 0.1 Production target of 170,000 b/d
Gharaf Petronas, Japex 0.9 Production target of 230,000 b/d
Halfaya CNPC, Total, Petronas 4.1 Plateau of 535,000 b/d
Majnoon Royal Dutch Shell, Petronas 12.6 Plateau of 1.8 mn b/d
Najma Sonangol 0.9 Production target of 110,000 b/d
Qayara Sonangol 0.8 Production target of 120,000 b/d
West Qurna (Phase 2) Lukoil, Statoil 12.9 Production target of 1.8 mn b/d
Source: Upstream Online, Kotak Institutional Equities
NGL supply is rising and so is Non-OPEC supply in CY2010E. We note that the
supply-demand balance of crude oil looks fairly comfortable in CY2010E, led by
increased supply of NGLs (0.8 mn b/d) and from Non-OPEC countries (0.2 mn b/d).
Also, OPEC capacity will likely increase by 0.8 mn b/d.
Excess refining supply; in fact, refineries are being shut. A strong recovery in auto
fuels demand has been one of the arguments for a more bullish view on oil. Inventory
data for the US over the past few weeks shows a decline in gasoline inventories.
However, we believe this merely reflects low refining capacity utilization in the US (see
Exhibit 5) rather than any great resurgence in gasoline demand. Gasoline demand
remains at the lowest level in the last five years (see Exhibit 6). Finally, refining is hardly
a bottleneck given low global capacity utilization rates; it’s not as if the world is
running out of refining capacity.
KOTAK INSTITUTIONAL EQUITIES RESEARCH 9

10.
India Energy
US refining capacity utilization lowest in a decade
Weekly refining utilization in US (%)
US refining capacity utilization
(%)
105 2000-2009 range 2010 2005
2006 2007 2008
2009
95
85
75
65
Mar
Apr
Oct
Jan
Feb
Jun
Aug
Sep
May
Nov
Dec
Source: IEA, Kotak Institutional Equities
Gasoline demand lowest in last five years
Weekly gasoline supplies in the US (mn b/d)
(mn b/d)
10 2000-2009 range 2006 2007 2008 2009 2010
9
8
7
Jan
Feb
Mar
Apr
Jun
Aug
Sep
Oct
Nov
May
Dec
Source: EIA, Kotak Institutional Equities
Crude and product inventories look ample, especially in the light of declining
OECD consumption. Exhibits 7 and 8 show OECD inventories in terms of absolute
and number of days of forward cover. We note that OECD demand has declined over
the past few years and the IEA predicts that OECD demand may in fact have peaked.
OECD demand has declined 1 mn b/d on an average over the past four years although
the decline in demand may have been accelerated in the past two years by the global
credit crisis (see Exhibit 9).
10 KOTAK INSTITUTIONAL EQUITIES RESEARCH

14.
India Energy
Relationship between crude prices and Dollar index seems to be strong since 2003
WTI and Dated Brent crude oil prices versus DXY Index, 2003-10YTD
(US$/bbl)
160 USCRWTIC Index [LHS] EUCRBRDT Index [LHS] DXY Index [RHS] 110
140 Correlation (Crude, DXY) = -0.8
120 100
100
80 90
60
40 80
20
- 70
Jan-03
Jul-03
Jan-04
Jul-04
Jan-05
Jul-05
Jan-06
Jul-06
Jan-07
Jul-07
Jan-08
Jul-08
Jan-09
Jul-09
Jan-10
Source: Bloomberg, Kotak Institutional Equities
In our view, long-dated prices reflect the market’s current knowledge of future supply
and demand even assuming that they are not influenced by short-term prices. However,
we believe that current knowledge of geology and technology will never be able to
assess (1) availability of resources in unexplored areas (most of the world’s oceans
including the emerging Arctic area, non-conventional resources) and (2) future
advancements of technology in areas of extraction technology, electric batteries and solar,
wind and nuclear power. More often than not, these technological breakthroughs will be
of a ‘game-changer’ variety.
For example, the recent flurry of news on and activity around shale gas suggests that this
is a very exciting area of supply of natural gas. Technological advancements have finally
allowed commercial exploitation of resources that have been known to geologists for the
past 3-4 decades. Various sources have estimated the resource base at 5-6X against
current proved natural gas reserves of 1.2 tn boe (185 tcm). We note that shale gas is no
longer in the realm of futurology but is playing an increasingly important role in the US
energy scene. Shale gas now accounts for 14.7% of total US natural gas production (see
Exhibit 14 that shows rising contribution of shale gas total US gas production).
14 KOTAK INSTITUTIONAL EQUITIES RESEARCH

16.
CAUTIOUS
Telecom
India MARCH 19, 2010
UPDATE
BSE-30: 17,578
Run-up to the 3G/BWA spectrum auctions—part I. In line with our expectations, the
‘fear of the known (potential value loss from not having a 3G offering)’ has attracted 9
applications for the 3 3G spectrum slots being auctioned. Rather unexpectedly,
however, the ‘option value or hope from the unknown’ has attracted 11 applications
for the 2 BWA slots being auctioned. As highlighted in our March 15 report, we expect
(1) aggressive bidding and (2) value destruction for the sector. Retain Cautious view.
3G—9 applicants for 3 slots; BWA—11 applicants for 2
The Department of Telecommunications has received 9 applications for the 3 (in 17 circles, 4 in 5)
3G spectrum slots being auctioned, while 11 firms have submitted their applications for the 2
BWA slots being auctioned to private players. We note that BSNL/MTNL have already been allotted
3G/BWA spectrum and they would not be a part of the auction. We also highlight that we do not
have any circle-level details yet—some of these applicants may not have put in an application for
all the 22 circles.
Exhibit 2 depicts the names of the applicants for the 3G and BWA spectrum auctions. On expected
lines, the top-6 wireless operators in the country (Bharti, Vodafone, RCOM, Idea, the Tata Group—
TTSL/TTML/TCOM, and Aircel) have submitted applications for both 3G and BWA spectrum
auctions. Three new players viz. Etisalat DB Telecom, Videocon, and S Tel have applied for 3G
spectrum auctions (though we suspect Etisalat and S Tel may not bid pan-India), while there are 5
other applicants for BWA spectrum auctions.
‘Fear of the known’ and ‘hope from the unknown’ drives high # of bids for 3G/BWA auctions
3G—fear of the known: As discussed in our March 15 report on the upcoming auctions, we had
anticipated the ‘fear factor’ of not winning 3G spectrum and facing potential value loss from high-
ARPU subs churn (see Exhibit 3), to drive serious participation from all the large 2G incumbents in
the 3G spectrum auction. We expect bidding for 3G spectrum to be aggressive—we expect pan-
India 3G spectrum auction clearing price to be around US$2.5 bn, with the GOI netting US$10.3
bn, including payments from BSNL and MTNL (who have to match the auction clearing price).
BWA (broadband wireless access)—hope from the unknown: Wimax networks are expected
to solve the last-mile access challenge that has plagued broadband penetration in India (less than
1%, compared to wireless penetration of 45%). The excitement of ‘yet unknown but potentially
large BB opportunity’ will likely ensure aggressive participation in the BWA auctions as well—the
large number of applications (11) for the 2 BWA slots to be auctioned can be seen as an indicator
of the same. We had assumed the BWA auctions to clear at the reserve price of US$380 mn per
slot (a total of US$1.14 bn from 3 slots—2 for private players and 1 for BSNL/MTNL) in our March
15 report; aggressive bidding poses upside risk to this estimate as well and the GOI could reap
more than the US$11.4 bn we have estimated, from the 3G and BWA auctions.
Auctions good for the fisc, negative for the sector—we remain Cautious
We believe the upcoming 3G spectrum auction will be a negative for the winners as well as the
losers. We expect the winning operators to end up paying more than the potential ‘tangible’ value
creation from rollout of 3G services, even as the tangible ‘value accretion’ for the winners happens
(at least partially) at the expense of the losers. We believe the Street would take cognizance of the
potential negatives from these auctions as the auction date (April 9) comes closer, and continue to
remain Cautious on the sector. We reiterate REDUCE on Bharti and Idea, and SELL on RCOM.
For private Circulation Only. FOR IMPORTANT INFORMATION ABOUT KOTAK SECURITIES’ RATING SYSTEM AND OTHER DISCLOSURES, REFER TO THE END OF THIS MATERIAL.